BHP spinoff could prove hard to value

RhiannonHoyle

SYDNEY--When shares in BHP Billiton Ltd.'s spinoff company South32 start trading Monday it will complete one of the largest corporate breakups in mining history and, for Australia, the biggest market listing this century.

So much for the superlatives: Investors' main question now is what the new company is worth.

BHP shareholders this month voted almost unanimously in favor of carving out South32, a suite of assets including aluminum, nickel and manganese mines that BHP's top ranks believe will perform better apart from the giant mining company. BHP decided to call the spinoff South32 because most of the new company's assets are in Australia and South Africa, which are linked by the 32nd parallel south line of latitude.

When BHP first announced its breakup plan last August, some analysts reckoned South32 could be worth as much as US$15 billion. But estimates have since diverged, as commodity prices have come under pressure. Investec Securities, for example, now suggests South32 could have a market value as low as US$7 billion.

Assessing South32 is tricky because of the cocktail of unpredictable elements that go into its valuation: in particular, the likely paths of the Australian dollar, South African rand and aluminum, coal and manganese prices.

"There are so many variables, each highly volatile and difficult to forecast," said George Boubouras, chief investment officer at Contango Asset Management, who says it has been "like a Monty Python sketch" trying to calculate South32's worth. "It has been a wonderful challenge for us," he said.

Skeptics worry the price outlook for South32's industrial commodities has been souring.

Aluminum--which, with key ingredient alumina, will account for 29% of South32 earnings based on BHP's most recent full-year results--has whipsawed between US$1,755 and US$2,120 a ton over the past year, with prices most recently weighed down by fears that rising Chinese exports will create a market glut.

Manganese, used in steelmaking and which accounts for 21% of likely earnings, has also fallen sharply this year on signs of excess supply. Coal has been in a prolonged market slump; it accounts for roughly 19% of the business's earnings.

Political risk clouds South32's outlook too. The company has a large number of assets in South Africa, where the mining industry has been beset by labor disputes and insecure power supply.

But supporters have been impressed by South32's management, led by BHP's former chief financial officer, Graham Kerr, and a lower-than-expected debt burden for the new company.

"I still like the business mix, the balance sheet is nice, and I have some comfort in terms of the management," said Tim Schroeders, a fund manager at Pengana Capital, which manages more than 1.4 billion Australian dollars (US$1.13 billion), including BHP shares.

Others think investors may assign a premium to the stock as it could become an acquisition target. Among those out hunting is mining veteran Mick Davis; the former chief executive of Xstrata PLC has raised US$5.6 billion for a new mining fund, X2 Resources, that is searching for acquisition opportunities.

Mr. Kerr has described his strategy as "crawl, walk, run," meaning he will focus on reducing South32's costs before looking at growth through new projects or acquisitions. He has promised to return at least 40% of underlying earnings as dividends, a move that should appease yield-hungry investors.

Near term, trading in South32 may be volatile because it will be ineligible for inclusion in key U.K. stock market indexes as it isn't incorporated in that country. U.K. funds that track such indexes will have to sell shares they receive in the firm when it splits from BHP. Barclays estimates roughly 40% of U.K. holders will be forced to divest.

However, the stock's Australian listing should attract strong demand. The new company, based in Perth, will enter the S&P/ASX200 index; even at the low end of forecasts, the company will be one of the country's largest listed companies. South32 will also have a listing in South Africa.

Moreover, not all U.K.-based funds have to offload their stock.

"We can still hold and will hold, and we will see how the stock reacts," said Neil Gregson, natural resources fund manager at J.P. Morgan Asset Management. "If we were to see significant price weakness because of index selling, we could possibly be interested in picking up some more," Mr. Gregson said.

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